Spark still has room to grow

Strong and reliable dividends make
Spark Infrastructure
an attractive income play, but the utility owner also has some growth potential that analysts reckon the market may have overlooked.

Spark’s distribution yield of 8.4 per cent is towards the lower end of the utility infrastructure space, given the average distribution yield is about 9.4 per cent. But its “look-through" free cashflow (dividends reinvested plus those paid to investors) of 16 per cent is the sector’s highest and almost 4 percentage points above the average. This has led Royal Bank of Scotland to describe Spark as “the most bankable yield in the space".

Credit Suisse has forecast yields of between 20 per cent and 23 per cent next year on a look-through basis, compared to the range within Spark’s peer group of between 8.1 per cent and 16.9 per cent.

Tribeca Investment Partners’ portfolio manager Sean Fenton said: “Spark is more than just a pure yield play. They have some growth in their underlying assets as well."

Spark plans to use the free cashflow to fund capital expenditure growth and de-lever. Credit Suisse analyst Sandra McCullagh said the market was not pricing for this and the stock could return as much as 30 per cent (including the 9 per cent dividend yield) based on her discount cash flow and sum-of-the-part valuations. Spark is trading on a one-year forward price-to-earnings multiple of 13.8.

Spark recently underwent a strategic review in which it changed its corporate structure and guidance on future dividends. It has provided guidance on its distributions for the second half of 2010 and financial year 2011, but Credit Suisse thinks it could do more.

The broker has argued that by the end of next month, Spark will have more clarity on forward capital expenditure and revenue allowances until fiscal 2014.

The broker considers the market would ascribe more value to Spark if it provided four-year distribution guidance aligned with their regulatory timeline.

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Spark has just completed the institutional portion of a $295 million capital raising to pay down some of its corporate debt and maintain its dividend. Some investors were surprised by the decision, given maturing debt had recently been refinanced. Some investors said they would have preferred the company to have cut the dividend and reinstated the dividend reinvestment plan.

But Mr Fenton said if Spark thought raising equity was the best option, he preferred that to running the balance sheet too tightly. Tribeca took up all of its entitlement, as did about 96 per cent of Spark’s other institutional investors. A book-build for the remaining 4 per cent is understood to have been heavily oversubscribed.

The institutional portion of the capital raising was for $165 million of new securities. The retail portion will remain open until October 21.

One disappointment of the review was that a conditional offer for the business, at a significant premium, failed to go ahead. Spark had one of the most complex corporate structures within the domestic utilities sector, and investors had hoped a bidder for the company might emerge once the structure had been simplified.

Since listing in 2005, Spark has consisted of a quintuple-staple structure comprising three holding companies, a trust and loan notes. This minimised the tax paid at group level and ensured the efficient pass-through of pre-tax cash flows to investors, but investors wanted a simpler and more transparent structure.

Spark’s conversion to a dual-stapled security comprising of a trust and loan notes means distributions will be cut from 12.32¢ a share in 2010 to 9.11¢ a share (7¢ a share interest and 2.11¢ a share capital return).